HealthEquity, Inc. — Q2 FY2022 Form 10-Q
Reporting period: Quarter and six months ended July 31, 2021. Financial statements are unaudited. Amounts are in U.S. dollars; financial statement figures are in millions unless otherwise noted.
Business context
HealthEquity administers health savings accounts (HSAs) and other consumer-directed benefits. At July 31, 2021, it administered 5.97 million HSAs with $15.47 billion in HSA assets, 7.17 million complementary benefit accounts, and 13.14 million total accounts.
Financial performance
| Metric | Three months ended July 31, 2021 | Year-over-year change | Six months ended July 31, 2021 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $189.1 | +7% | $373.3 | +2% |
| Gross profit / margin | $112.0 / 59.2% | Margin up from 57.8% | $215.1 / 57.6% | Margin up from 57.3% |
| Operating income (loss) | $(0.9) | Down from $9.0 | $3.4 | Down from $24.1 |
| Net income (loss) | $(3.8) | Down from $(0.1) | $(6.4) | Down from $1.7 |
| Adjusted EBITDA | $65.5 | +9%; 35% of revenue | $124.5 | +1%; 33% of revenue |
Quarterly revenue growth reflected higher interchange revenue (+23%), service revenue (+5%), and custodial revenue (+4%). For the six-month period, service revenue declined 2%, primarily due to suspended commuter accounts, while interchange revenue rose 15% and custodial revenue rose 2%. Custodial revenue growth was partly offset by lower yields: quarterly average annualized yield on HSA cash with yield fell to 1.77% from 2.10%.
Operating expenses rose 22% in the quarter and 14% year to date. Merger integration costs were $16.4 million for the quarter and $25.2 million year to date; acquired-intangible amortization was $20.3 million and $40.1 million, respectively. Quarterly diluted loss per share was $0.05; six-month diluted loss per share was $0.08.
Cash flow, liquidity and debt
- Six-month operating cash flow was $68.2 million, versus $68.7 million in the prior-year period. Investing cash outflow was $88.3 million, including $49.5 million for Luum and $32.1 million for software and capitalized development. Financing cash inflow was $445.1 million.
- Cash and cash equivalents were $753.8 million at July 31, up from $328.8 million at January 31. The increase principally reflected $456.6 million of net proceeds from a follow-on share offering; $50.2 million of those proceeds funded the Luum acquisition.
- Term-loan principal was $987.5 million; carrying debt, net of issuance costs, was $973.6 million, including current and long-term portions. No revolving-credit borrowings were outstanding; the facility provides up to $350 million. The stated loan rate was 1.84% and effective rate 2.37%. The company reported compliance with debt covenants.
- Management said existing cash, operating cash flow, and revolving-credit availability should cover operating and capital needs for at least 12 months. Capital expenditures were $38.4 million in the first half, and the company expected elevated spending to continue for the rest of FY2022.
Material changes, outlook and notable items
- The company acquired Luum in March for $50.2 million cash, with up to $20 million in contingent payments. The contingent-consideration liability was $9.2 million at July 31. Luum added $36.4 million of goodwill.
- HealthEquity reported approximately $70 million of the WageWorks acquisition’s targeted $80 million in annualized ongoing net synergies achieved by July 31. It expected WageWorks integration expenses to conclude by fiscal year-end 2022, apart from certain continuing lease costs. Management described about $100 million of expected WageWorks integration costs and about $55 million for Further.
- A Fifth Third Bank HSA portfolio transfer, contemplated at $60.8 million for approximately 149,000 members and $477 million of assets, was expected to close by the end of fiscal Q3, subject to conditions.
- After quarter-end, the Further acquisition terms were amended: $455 million for the remainder of the business, targeted to close November 1, 2021, and a separate VEBA-related transaction for up to $45 million, anticipated to close January 31, 2022. Both were subject to closing conditions.
- No specific revenue or earnings guidance was provided. Management expected sales and marketing and technology-and-development expenses to rise in the foreseeable future, and continued to identify low interest rates, COVID-19 effects, and suspended commuter activity as business headwinds. The Delta variant could further delay return-to-office and commuter-benefit recovery.
- A WageWorks-related securities class action settled for $30 million; WageWorks contributed $5 million and insurers paid $25 million. The court granted final approval on August 20, 2021. A landlord disputed HealthEquity’s termination of an uncommenced lease with $63.1 million of undiscounted payments; no lease asset or liability had been recorded.
Risks and controls
- Management concluded disclosure controls were ineffective because of material weaknesses in WageWorks’ internal controls involving accounting close and reporting, contract-to-cash processes, and IT general controls. Remediation and integration work was ongoing; management stated the condensed consolidated financial statements were fairly presented.
- Custodial revenue remains sensitive to interest rates and deposit-partner terms. A 1-percentage-point increase in the rate on outstanding credit facilities would add an estimated $9.6 million of interest expense over the next 12 months.
- Most of the company’s $753.8 million of cash was above federal deposit-insurance limits. The filing also highlights counterparty risks for custodial assets held with depository and insurance partners, COVID-19 and operational risks, acquisition execution and integration, regulatory and tax changes, cybersecurity, and talent retention.
Investor verification priorities
- Track whether revenue growth and the improvement in gross margin persist, while separating recurring performance from temporary COBRA subsidy-related revenue and acquisition effects.
- Verify integration costs, synergy realization, and the timing, final consideration, and funding of the Further and Fifth Third transactions.
- Monitor cash deployment, term-loan repayment, variable-rate exposure, and covenant headroom as acquisitions proceed.
- Follow remediation and testing of WageWorks’ material control weaknesses and any subsequent changes to management’s controls assessment.
- Check the outcome of the disputed lease termination and any material developments in other litigation or tax examinations.